DBRS Morningstar Confirms National Australia Bank’s LT Issuer Rating at AA, Stable Trend

DBRS Ratings Limited (DBRS Morningstar) confirmed the ratings of National Australia Bank Limited (NAB or the Bank), including the Long-Term Issuer Rating at AA and the Short-Term Issuer Rating at R-1 (high). The trend on all ratings is Stable. The Intrinsic Assessment (IA) of the Bank is AA (low) and the Support Assessment is SA2, which reflects the generally supportive regulatory framework and DBRS Morningstar’s expectation of timely systemic support, given NAB’s importance to the financial system in Australia. This results in a one notch uplift to the Issuer Rating from the IA. See a full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS

The confirmation of the ratings reflects NAB’s strong domestic franchise, particularly in business banking, as well as its robust asset quality with low levels of impaired loans, its sound customer deposit base and its strong capital levels. The ratings also reflect the Group’s sound earnings generation, which has been recently supported by higher net interest income. However, the ratings also take into account that NAB continues to make extensive usage of wholesale funding, which represented 29% of non-equity funding at end-FY22, and which is higher than most domestic and international peers. In addition, DBRS Morningstar considers that it remains important for NAB to continue addressing risk shortcomings, including the additional AML weaknesses flagged by AUSTRAC in FY22.

RATING DRIVERS

An upgrade of the ratings would require the Bank to further diversify and improve profitability while maintaining sound asset quality. It would also require the Group to reduce its reliance on wholesale funding.

A downgrade of the ratings could be driven by prolonged weakening of profitability and asset quality as well as material additional risk shortcomings, and/or a failure to satisfactorily resolve past misconduct issues. In addition, a downgrade of the ratings would occur if, in DBRS Morningstar’s opinion, the likelihood of timely systemic support were reduced.

RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Very Strong / Strong
NAB is one of the four leading Australian banks and has meaningful market shares in business lending in Australia and New Zealand of around 22%. Similar to its domestic peers, NAB has over the past few years focused on simplifying and digitalising its core business, which has been done through several divestments and strategic acquisitions, with the last one being the sale of BNZ Life to Partners Life in FY22. In June 2022, NAB completed the acquisition of Citigroup’s Australian consumer business, reinforcing the Group’s domestic position in consumer lending particularly in unsecured lending. The transaction was manageable from the capital perspective with a negative 30 bps impact on CET1.

Earnings Combined Building Block (BB) Assessment: Strong / Good
DBRS Morningstar considers that NAB has generally reported strong earnings. In FY22, NAB reported statutory net attributable profit was AUD 6,891 million, up 8.3% year-on-year (YoY), helped by improved results across all divisions except Personal Banking, largely on the back of net interest income (NII) growth. NII, which is the main source of revenue, accounted for 81% of total income in FY22, and it was up 8% YoY reflecting higher new lending volumes and the higher interest rates. The net interest margin (NIM), however, was under pressure and reduced to 1.65% in FY22 driven by intense competition particularly for home loans. Despite this, costs have been generally kept under control, although statutory operating expenses were up 5.8% in FY22 YoY reflecting inflationary pressure as well as higher spending on technology investments and higher costs from remediation and compliance. NAB’s cost-income ratio, on a statutory basis, nevertheless, was sound at 45.2% in FY22, and broadly stable from the year before. Loan impairment charges were higher YoY after significant loan loss reversals in FY21 but still at historically low levels.

Risk Combined Building Block (BB) Assessment: Strong
NAB has a conservative risk profile, robust asset quality and low levels of impaired loans. Stage 3 loans, which are non-performing loans, totalled AUD 6.1 billion and were down 12% largely reflecting higher recoveries on mortgages. They represented 0.89% of NAB’s total gross loans at end-FY22, an improvement from 1.12% at end-FY21 and below pre-pandemic levels. Since FY19, Stage 2 loans, which are loans that are performing but where there has been an increase in credit risk, have grown substantially YoY, to AUD 181.3 billion, up from AUD 99.4 billion at end-FY19 and AUD 156.9 billion at end-FY20. Stage 2 loans represented a high 26% of total gross loans at end-FY22, significantly up from 17% at end-FY19, which is significantly higher than at the other large Australian banks. NAB’s commercial real estate (CRE) portfolio amounted to AUD 65.9 billion at end-FY22, accounting for 9.6% of total gross loans. Whilst exposure to this sector is slightly higher than at domestic peers, NAB’s CRE portfolio continues to perform well and impaired loans only represented a low 0.25% of total gross loans at end-FY22.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong / Good
NAB’s funding mix has improved over the years, largely supported by growth in customer deposits. Customer deposits, including certificates of deposits (CDs), totalled AUD 616.7 billion at end-FY22, up 13.3% from end-FY21 largely driven by deposit growth in Australia. The Bank's net loan-to-deposit (LTD) ratio, as calculated by DBRS Morningstar including CDs was 111%, down from 114% at end-FY21, and lower than the 128% level at end-FY19. However, NAB continues to make large utilisation of wholesale funding, which accounted for 29% of non-equity funding. At end-FY22, NAB had a higher reliance on short-term wholesale funding than domestic peers. At end-FY22, short-term funding increased 24% YoY to meet the reduction of the Committed Liquidity Facility (CLF). NAB's liquidity remains strong. The Group's quarterly average Liquidity Coverage Ratio (LCR) at end-September 2022 was 137% (or 128% excluding the CLF), while its Net Stable Funding Ratio (NSFR) ratio was 119% at end-September 2022.

Capitalisation Combined Building Block (BB) Assessment: Strong
NAB’s capital position is strong, supported by solid earnings generation, and the Group is well-placed to meet the upcoming regulatory changes to the capital and loss absorbing capacity frameworks. On an “internationally comparable basis”, NAB's CET1 ratio was 16.89% at end-FY22. The Bank reported an APRA Common Equity Tier 1 (CET1) ratio of 11.5% at end-FY22, down 149 bps from 13.0% at end-FY21, mainly driven by the on-market share buyback of AUD 3.9 billion, the acquisition of Citi consumer business, and higher Risk Weighted Assets as a result of widening of the swap rates. Nonetheless, the Bank's CET1 ratio is comfortably above APRA’s new regulatory requirement of 10.25% set from 1st January 2023. The Group’s leverage ratio, calculated on an APRA basis as Tier 1 Capital as a percentage of total exposure, was solid at 5.06% at end-FY22.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/405768

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Governance (G) Factors
The subfactor ‘corporate governance’ is relevant to the rating of NAB and this is reflected in the Risk building block. Meaningful operational shortcomings were identified for NAB as part of the industry wide Royal Commission investigation in February 2019 and as part of the 2018 Self-Assessment report. In April 2022, NAB accepted an ‘enforceable undertaking’ (EU) after AUSTRAC had identified several weaknesses with NAB’s compliance of anti-money laundering and counter-terrorism financing (AML/CTF). The EU requires NAB to implement a detailed Remedial Action Plan detailing the bank’s plans to improve its compliance systems, controls and record-keeping. DBRS Morningstar expects that any fine, if imposed, will be manageable from the capital perspective given the Group’s sound capital position and strong internal capital generation. DBRS Morningstar considers NAB to make good progress in addressing past operational issues and continues to work on implementing the remediation plan agreed with AUSTRAC, although the capital add-on of AUD 500 million remains in place. However, the additional AML weaknesses found in FY22 highlight in DBRS Morningstar’s view that it remains important that NAB continues addressing its operational risk issues. The EU will end when the AML/CTF related remediations have been completed to AUSTRAC’s satisfaction.

There were no Environmental or Social factors that had a significant or relevant effect on the credit analysis

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings. (May 17, 2022)

Notes:

All figures are in AUD unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations https://www.dbrsmorningstar.com/research/398692/global-methodology-for-rating-banks-and-banking-organisations (June 23, 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings (May 17, 2022) in its consideration of ESG factors.

The sources of information used for this rating include Morningstar Inc. and Company Documents, National Australia Bank (NAB) Annual Report 2022, NAB FY2022 Investor Presentation, NAB FY2022 Management discussion and analysis, NAB Climate Report 2022. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/405769

This rating is endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Maria Rivas, Senior Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Head of Global FIG
Initial Rating Date: 24/01/2005
Last Rating Date: 26/11/2021

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